Comparison study of literary economics between Iceland's recent euphoria and the Roaring 20s in the US 80 years ago. Iceland's bubble was strikingly similar to events 80 years ago.

1. Once In Khaki Suits: Socioeconomical Features of the Icelandic Collapse Már Wolfgang Mixa Brother Can You Spare a Dime, a song written in 1932, focuses on the glory times of the Roaring Twenties and laments what has since then been known as the Great Depression. Production soured during the 1920s, with GNP rising nearly by half and per capita income more than a third during a period of nonexistent inflation (Gordon, 2000). Ever since has this boom and bust period been discussed and debated with no conclusion in sight. Iceland enjoyed an enormous boom period which started in 2003 and ended with a sudden bust in the fall of 2008, eclipsing most historical ones. Since it occurred, the discussion regarding the Icelandic collapse has focused almost entirely on two factors. One is regarding the expansion of the banking system which - it is claimed - nobody seemed to either have the powers to control or the willingness to do so. The second discussion, which relates somewhat to the first one, focuses on corruption and ineptness, which in Iceland’s case has in many instances been defined as crony capitalism. A common question is whether these aspects made it foreseeable that an economic collapse was in the making. Many individuals that have been blamed for causing the meltdown deny such accusations vehemently, maintaining that this was an abnormal and unforeseeable storm hitting shores only once in a 100 years. Using a qualitative approach, not a quantitative one, often referred to in the field of economics as behavioral finance or literary economics (Kindleberger, 1996), sheds another dimension of how foreseeable the bust due to the speculative mania was in Iceland. This approach is uncommon today, as most major finance textbooks convey a sense of orderly progression of financial markets working with mathematical precision (Shiller, 2001a). This approach is, however, far more conducive than a purely quantitative perspective according to some economists. Chancellor maintains that social and political attitudes are equally important in determining a course of a mania (Chancellor, 2000). Robert J. Shiller states that there are seldom simple causes of historical events (Shiller, 2001a). There simply is such an ambiguity within financial markets that exactness in excel sheets face limitations in the real world. Shiller still identified in his already classic book, Irrational Exuberance, 12 precipitating factors of what today is commonly known as the dot.com bubble, that then had an effect on market prices which rational analysis of economic fundamentals do not explain (Shiller, 2001a). Of those 12 factors, 11 can be seen as applicable to the social landscape in Iceland during the boom period 2003 until the dramatic bust. This essay sheds a light on some of those factors and is thus in essence a study of socioeconomics. Since the current crisis is commonly said to be the worst one since the Great Depression, some of those applicable factors are compared to its prelude, the Roaring Twenties, showing a remarkable similarity between the two periods despite being 70 years apart. The first part gives a general discussion regarding social signs of a bubble. That leads to a discussion of variables identifying such danger signs. A few variables are applied to the Roaring Twenties in the US and then to the recent euphoric period which conquered Iceland. The discussion should show that danger signs could not only be detected by glancing at macro numbers or balance sheets of banks but also by detecting the development of society in Iceland as a whole. Such a comparison provides an explanatory basis on aspects that may have re-enforced a climate which allowed the seeds of the economic collapse to occur. It locates the current Icelandic crisis within a historical and international perspective. Signs of Affluence - Once I Built a Tower Foreigners and especially Icelanders living abroad, visiting Iceland told me during the years before the crash how astonished they were at what they saw. Icelanders drove in new and expensive cars, black Range Rovers being the main status symbol, practically all households had new flat screen TVs and people, especially young people, seemed to live in a lap of luxury, even those who were barely yet part of the labor force. This was an illusion; household debt compared to disposable income went up almost 20% 2003-2007 with a negative savings rate during the period (OECD, 2009). New buildings were being built all over the capital. It was reported that when Robert Aliber, a world famous expert on financial crises, came to Iceland in spring 2008 and warned of grave dangers ahead after driving around Reykjavik counting the number of building cranes, a classic sign of a build-up of a bubble economy, stating in a public speech during the same trip, “You’ve got a year before the crisis hits.” (Wade, 2009, p.4). Another symbolization was the tallest building made in Iceland, the Smara Tower, completed during the summer of 2008. This is a classic example of what is called the “erection index”, having often predicted accurately a top of a bull market. The tallest building in the world was completed in Malaysia a few months before the onset of the Asian crises in 1997 and also in the 1920s when Raskob and Chrysler were in a war of building the nations tallest building (Raskob won with the Empire State Building) (Chancellor, 2000). Such signs of affluence as described above re-enforce a feeling of well being and optimism. This creates “a sort of feedback, from price increases, to increased investor enthusiasm, to increased demand, and hence further price increases” (Shiller, 1995, p.3). Even investment professionals fall into such traps. This includes those who are skeptical regarding recent financial fads, since most of them have to deal with clients who often expect them to follow them (Shiller, 2001b). Even if the professionals happen to be eventually proven right, going against the grain may cost them their jobs in the meantime, which is rumored to have occurred a great deal during the dot.com period. That was the financial climate connected with the abundant opportunities the Internet promised when Shiller listed the 11 precipitating factors of a bubble in Irrational Exuberance which are also relevant to the Roaring Twenties and the euphoric period in Iceland 2003-2008 are: 1.The arrival of the Internet at a time of solid earnings growth 2.Triumphalism and the decline of foreign economic rivals 3.Cultural changes favoring business success or the apearance thereof 4.A republican congress and capital gains tax cuts 5.An expansion in media reporting business news 6. Analysts´ increasingly optimistic forecasts 7.The expansion of defined contribution pension plans 8.The growth of mutual funds 9.The decline of inflation and the effects of money illusions 10.Expansion of the volume of trade: Discount brokers, day traders, and twenty-four-hour trading 11.The rise of gambling opportunities Shiller’s list clearly reflects that the attention span of the general public leans toward monetary issues. The interconnected causes and effects of such developments are difficult to determine. These factors are correlated but the growth of mutual funds is obviously a result of added optimism which, by rising higher values of underlying assets, then also becomes self-fulfilling. The main factors generally associated with financial bubbles are an expansion of bank credit, leading to rising asset prices and eventually speculation in overtrading (Kindleberger, 1996). This is further amplified when firms or households see others making money by speculative trading, adding a tendency to follow the crowd: “Monkey see, monkey do.” As Kindleberger puts it: “There is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.” (Kindleberger, 1996, p.13). Shiller states that it becomes difficult judging objectively without being influenced by recent success behavior related to market investments (Shiller, 2001b). This leads to herd behavior in such investment styles (or taking questionable loans as Iceland’s recent experience with foreign denominated loans demonstrates) since people assume that others have information justifying their actions (Shiller, 1995). A banker subscribing to the South Sea stock (an infamous bubble in 1720) gave a neat example saying: “When the rest of the world are mad, we must imitate them in some measure.” (Carswell, 1960 quoted in Avgouleas, 2008, p.11). Communication - Once I Built a Railroad A common factor concerning socioeconomic developments leading to increased optimism about the future is a new format of technology making communication easier and the world thus seeming to be a smaller and unified place. The advent of the Internet was only one of the many factors in that regard that have caused excessive optimism regarding future communication in enhancing business. Such ways of making the world more interconnected were, however, at first mainly linked with transportation. Railway stocks became the dot.com craze of the 18th Century on both sides of the Atlantic, causing a revolution in passenger and freight transportation. It is not only the amount of perceived communication in creating a smaller world which matters, but no less the content and who controls it. Content wise, Shiller points out, added business news reporting is not necessary a sign of a bubble. It is excessive reporting that is such a sign. During the dot.com bubble, many brokers found it necessary keeping the financial TV network CNBC constantly on their computer screens because so many clients called regarding the latest story on the networks that by not keeping up with the media, as opposed to be working, they seemed to be behind the curve (Shiller, 2001a). The author of this article knows that feeling, formerly working as a stock broker, hearing the networks in the background of customers calling for “advice”, scrambling to convey some relevance to the conversation. The Roaring Twenties - Building a Dream The US population considered itself being part of a new era during the 1920s. The Federal Reserve, established 1913 in wake of the Crash 1907, was believed having omnipotence and thus having powers to effectively abolish business cycles by controlling interest rates and conducting open market operations. Booms, slumps, and panics were supposed to be a thing of the past (Chancellor, 2000). More efficient means of industrial organization in addition to the use of electricity, meant that the effective price of an automobile for the average worker fell from the equivalent of nearly two years’ before World War I to about three months’ earnings in the late 1920s (Kennedy, 1999). The era thus experienced a new revolution of transportation, the first major one since the railways almost a century earlier, as the automotive industry became among the main engine of the American economy. Only 1.26 million passenger cars were on the road in 1914 but by 1929 alone the country produced 5.6 million (Gordon, 2000). The aviation industry also began degree drawing attention. Charles Lindberg’s flight to Paris in 1927 created a craze in airline stocks, even though many of the companies had yet to fly an airliner (Gordon, 2000), helping to bolster the psychological national confidence in unlimited possibilities of life, especially in America (Brooks, 1969). The radio in the 1920s had a similar effect on society as the Internet around the turn of this century. In the US, radio broadcasting to the public began fall 1920; two years later it had become a craze. By 1929 sales of radios and accessories were 14fold the amount it was in 1922 (Allen, 1931). This added to the trend of people following the same news all over the country due to the formation of newspaper syndicates. While the number of daily papers steadily dropped, the circulation increased of each one, with syndicated writers replacing local ones. This made news more centralized and tickling the mass mind (Allen, 1931). Added centralization within society mirrored an optimistic and re-enforcing trend during the 1920s in the US. Galbraith notes that “most magazines and newspapers in 1929 reported the upward sweep of the market with admiration and awe and without alarm.” (Galbraith, 1997, p.72). Over the 1920s the number of articles about the stock market almost quadrupled, with discussions of the stock market typically being a subject at various social events (Shiller, 2001a). Market operators became celebrities, among who were two great bank chairmen, Mitchell of National City and Wiggin of the Chase, famed international financer Ivar Kreuger and soon to become president of the New York Stock Exchange, Richard Whitney (Galbraith, 1990). They all lost fortunes following the Crash, with Kreuger committing suicide in 1932 (Fisher, 2007). Research departments were not known during that period so analyst opinions were mainly economists. Optimistic expressions came from Harvard, Yale, Michigan, Ohio State and Princeton, or basically all the major institutions (Sobel, 1968). By far the most infamous statement came from the academic sage Irving Fisher of Yale, heavily involved in the market himself, who in the autumn of 1929 gained eternal fame by publicly stating that “stock prices have reached what looks like a permanently high plateau.” (Allen, 1931, p.245) This phrase has become a classic, quoted repeatedly (it is for example quoted in Brooks, 1969; Chancellor, 2000; Shiller, 2001; Galbraith, 1997 & Gordon, 2000). Galbraith observed that “the striking thing about the stock market speculation of 1929 was not the massiveness of the participation. Rather it was the way it became central to the culture.” (Galbraith, 1997, p.78). In his 1931 book Only Yesterday, Frederick Lewis Allen wrote, probably with some exaggeration, of 1929: The rich man’s chauffeur drove with his ear laid back to catch the news of an impending move in Bethlehem Steel; he held fifty shares himself on a twenty-point margin. The window-cleaner at the broker’s office paused to watch the ticker, for he was thinking of converting his laboriously accumulated savings into a few shares of Simmons. (p.237) With the advent of new technologies and easy access to money, consumerism blossomed. According to Robert S. Lynd, stimulations at the greatest scale were attempted where family members bought a living as opposed to making things at home, with advertizing totaling in 1929 about 2 percent of the national income (McElvaine, 2003), fueled by installment buying (McElvaine, 2003). People begun considering it old fashioned limiting their purchases to their credit, with economists estimating that 15 per cent of all retail sales during the latter part of the decade were on credit. This atmosphere created a greater emphasis on advertising, which became an increasingly prominent feature of the media. That in turn intertwined with the added use of credit within an era where new appliances such as refrigerators and washing machines changed the daily routine at many homes, enabling women to enter the workforce in greater numbers than before, in a decade where electricity consumption doubled (Gordon, 2000). It is not only the content and amount of news shaping society which is a factor, but also how the news infiltrates society. Ben H. Bagdikian, a renowned journalist, maintains that the media has an immense power in shaping the public’s view of what is real and unreal and the weight of importance of certain issues (Ásgeirsdóttir, 2009). It can be derived that the media developed in a way that negative discussion regarding the outlook of the country and the negative effects of consumerism diminished. This spread to business reporting where negative comments were usually scrutinized. When Paul Warburg, among the most experienced bankers of the generation, said in early spring 1929 that prices were too high, a saturation point had already been reached in the colossal volume of loans and “the orgy of unrestrained speculation” needed to end, he was accused of “sandbagging American prosperity” (Sobel, 1968, p.126). This was the man who is generally credited of drawing up the blue print of what became the Federal Reserve Board and was a board member during its first five years (Fisher, 2007). Even president Hoover urged early in his presidency newspaper editors to warn their readers about stock prices, only to be met with little interest (Chancellor, 2000). Galbraith summarizes the sentiment by suggesting that while pessimism was not equated with an effort of destroying the American life, it had such connotations, meaning that those who voiced concerns did so with trepidation (Galbraith, 1997). The Icelandic Euphoria - Followed the Mob As in the US during the 1920s, the recent change of the economic landscape in Iceland had radically changed during the past years. In the spirit of the general approach of governing in the 1920s, i.e. doing nothing about most things (Fridson, 1998), the Icelandic government increasingly followed a laissez-faire policy, a key event when Iceland joined the European Economic Area in the early 1990s (Daníelsson & Zoega, 2009). Deregulation in the financial industry had taken place with restrictions of capital flows abolished. Authorities also lowered taxes, mainly favoring the rich via low capital gains taxes (Ólafsson, 2008), with corporate taxes lowered from 30% to 18% in 2002 (Matthíasson, 2008). These factors contributed to the bad distribution of income during the 1920s in the US (Galbraith, 1997) and such a development in Iceland 1995 and onwards, with wages only known in the US rapidly becoming part of Icelandic society (Ólafsson, 2008). Iceland was becoming more international by other means. As the economy grew and demand for labor remained high, an influx of immigrants came to Iceland, mainly from countries that joined the European Union in 2004, especially Poland (OECD, 2009). At the beginning of 1995 the amount of immigrants in Iceland was just over 5,000; that figure had grown more than fivefold in 2008 (Statistics Iceland, 2009). This is reminiscent of the trend in the US during the first decades of the 19th Century; in 1930 10% of Americans were born abroad with an additional 20% of people having at least one parent of foreign descent (see discussion in Kennedy, 1999). Increased immigration provides an atmosphere of added internationalism. A common sense of superiority within the countries to which immigration occurred may also have developed. The Internet influenced Icelanders a great deal, and probably more than other countries. The island had been isolated from the world media compared to most other western countries for decades. The advent of the Internet brought Icelanders in direct “contact” with the world. Although Internet usage is common by now, Icelanders have constantly been on the forefront in utilizing the Internet, adding to the new sense of internationalism. Some Icelandic analysts did raise concerns regarding economic features in the economy. Those concerns were, however, muffled within the optimistic outlook regarding stocks, the main engine of optimism. I do not recall any analyst raising concerns regarding the overvaluation of domestic stocks. Despite warnings on various issues, analyst presentations regarding broad economic features were generally upbeat and although the consensus was that lower growth was in store, maybe even a slight contraction, there were no indications that a meltdown was brewing. This is evident in an advertisement for a presentation regarding the economic outlook scheduled for Glitnir Bank October 1st, 2008. The title was Do I Need to Worry?, which in itself is hardly a stern warning signal, the discourse being that one should show caution but hardly that Armageddon was imminent. This is further demonstrated by the design of this newspaper advertisement in Fréttablaðið September 30th, 2008, as can be seen in Figure 1. Figure 1. An advertisement of a public meeting regarding household financial matters Among topics were How Do I Manage My Financials, Savings - Risks and Opportunities and The State of Glitnir in a Different Environment. Actually, the day before the advertisement was published the Central Bank overtook the operations of Glitnir Bank and the presentation was cancelled due to the “unforeseen turbulence in financial markets”. Even when danger signs were abundant at the start of 2008, Glitnir Bank’s research department remained upbeat towards stocks (it must be added that prices had fallen by half at that point from the peak). Its outlook for the year headlined that opportunities were hidden within the market, predicting a 30-40% rise of the Icelandic stock index during 2008 (markets were then in a tailspin, exact rise expectation thus difficult to determine). The report notably had Buy recommendations for all the financial firms listed, including the two holding companies, FL Group and Exista (Glitnir Research, 2008). The 1920s experienced an explosion in the formation of Investment Trusts (Fridson, 1998), many of whom leveraged themselves and bought in many instances shares of the issuing companies or related ones (Galbraith, 1997). FL Group and Exista were of a similar sort, particularly Exista. Its largest owners invested the bulk of the capital in companies belonging to them and their main associates, the food producer Bakkavör and Kaupþing Bank, in addition to the insurance company Sampo Group, which was rumored as being a take-over target of Kaupþing. Kaupthing Research initiated in fall 2007 research coverage of Exista with a report titled Right place, waiting for the right time, the title obviously indicative of a Buy recommendation (Ögmundsdóttir & Pétursson, 2007). The report still clearly shows that the Price to Book ratio was at the time of writing 1.5. While that may have been cheap compared to prior prices, Peter Högfeldt and Fredrik Synnerstad show that it was still well above the average of holding companies in Sweden, where the Price to Book ratio discount over longer time periods has been around 20 percent (Henrekson & Jakobsson, 2003). Compared to the average long term discount in Sweden of such companies, this was similar to people paying twice the amount of money for a combination of a few stocks which were mostly available in the open market but they yet had no control over. As with the fate of most of the Investment Trusts formed in the late 1920s (Galbraith, 1997), FL Group and Exista are in essence worthless. Given that the authors of the research report knew no better in their positive belief of this pyramiding company, can one blame the public, especially those still holding Exista shares waiting for the right time, for its gullibility? Summarization - Gee We Looked Swell Women’s emancipation was a distinctive feature in the 1920s. They smoked, drank alcohol and became increasingly part of the work culture (Chancellor, 2000). That changed during the ensuing depression when many people demanded that women, especially married ones, be fired to make way for unemployed men (McElvaine, 2000). During the euphoric years in Iceland, women only marginally participated in the ‘high society’ work culture, a distinctive feature being a limited participation of women within the financial community. As with the new casual clothing culture during the dot.com era, Icelandic business tycoons began abandoning wearing ties, giving them a sort of hard working persona. A short essay by John Kenneth Galbraith written in 1987, following the major crash that year, focuses on similarities between Wall Street’s then current landscape and in 1929. Galbraith mentions 4 distinctive parallels, all of which bear resonance to the recent landscape in Iceland. Three of them have been discussed in this essay, increased speculation and how it develops beyond any relation to underlying circumstances, financial structures such as holding companies involving added debt and leverage, and investment incentives of various sorts within a climate of widening distribution of income. Lessons derived from these parallels are scant, mainly that a world of high and confident finance is not new; the controlling fact as Galbraith puts it is the shortness of the public memory with a euphoric desire to forget. The fourth parallel is the constant of capitalism to single out the most punishment to those who lavished most the greatest gifts during the euphoria (Galbraith, 1987). Whether that will be the case in Iceland remains to be seen. References Allen, F. L. (1931). Only yesterday: An informal history of the 1920’s. New York: John Wiley & Sons. Avgouleas, E. (2008). Reforming investor protection regulation: The impact of cognitive biases. Retrieved September 9, 2009, from http://papers.ssrn.com/ sol3/papers.cfm?abstract_id=1293788 Ásgeirsdóttir, A. (2009). Áhrif eigenda á íslenska fjölmiðla? Unpublished master's thesis, University of Iceland. Brooks, J. (1969). Once in Golconda: A true drama of Wall street 1920-1938. New York: John Wiley & Sons Chancellor, E. (2000). 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Economic Surveys: Iceland 2009, 31, p. 36. Ólafsson, S. (2008). Íslenska efnahagsundrið: Frá hagsæld til frjálshyggju og fjármálahruns. Stjórnmál og stjórnsýsla, 233-256. Retrieved September 9, from http://www.stjornmalogstjornsysla.is/images/stories/fg2008h/ stefan08.pdf Shiller, R. J. (1995). Conversation, information, and herd behavior. Cowles Foundation Discussion paper 1092, abstract, 3. Shiller, R. J. (2001a). Irrational exuberance. New York: Broadway Books Shiller, R. J. (2001b). Bubbles, human judgement, and expert opinion. Cowles Foundation Discussion Paper No. 1303, 7, 13. Sobel, R. (1968). The great bull market: Wall street in the 1920s. New York: W.W. Norton & Company. Wade, R. (2009, January 13). Robert Wade’s speech in Reykjavik. Retrieved September 13, 2009, from http://economicdisaster.wordpress.com/ 2009/01/13/ Ögmundsdóttir, G. & Pétursson, H. I. (2007, September 26). Exista hf. Right place, waiting for the right time. Retrieved september 7, 2009, from http://www.kaupthing.is/lisalib/ getfile.aspx?itemid= 11683